SaaS Core Metrics: Strategic Implications

16-Nov-24

SaaS Core Metrics

Understanding core metrics is crucial for assessing a SaaS business's financial health, scalability, and strategic position. For CXOs, board members, and investors, these metrics provide critical insights into operational efficiency and customer value. This article examines essential SaaS metrics, detailing calculations, industry standards, the limitations of using SaaS Metrics and their implications for strategic decision-making.

Key Metrics to Track

1. Monthly Recurring Revenue (MRR) and Annual Recurring Revenue (ARR) MRR and ARR measure the steady, predictable revenue inherent to the SaaS model, which is central to financial forecasting and valuation.

• MRR Calculation: Total subscription revenue collected monthly. Formula: *MRR = ∑ (Subscription Fee x Number of Customers per Plan)/No. of months Example: For Plan A, 100 customers paying $100/month; For Plan B, another 50 customers are paying $250/quarter: MRR for Plan A = (100 customers x $100)/1 month = $10,000 MRR for Plan B = (50 customers x $250)/3 months = $ 4,167 MRR of the business is the sum of MRR for Plan A and Plan B = $14,167

*Some literature has used the formula to calculate MRR = ∑ Subscription Fee x Number of Customers per Plan. This will give an incorrect value in the above example for Plan B.

• ARR Calculation: Standardized to an annual figure, ARR projects revenue over a longer horizon. Formula: ARR = MRR x 12 Example: With MRR at $14,167/-, ARR is $170,000.
• Industry Standard: High-growth SaaS companies often have ARR growth rates of 30-50%, while mature firms target 15-25% (SaaS Capital, 2022).

References:

SaaS Capital ARR/MRR Benchmarks at https://www.saas-capital.com/research/

SaaS Capital, 2022 at https://www.saas-capital.com/blog-posts/growth-benchmarks-for-private-saas-companies/

2. Customer Acquisition Cost (CAC) CAC assesses the total expense incurred to acquire a customer, combining sales, marketing, and related costs. This metric’s alignment with revenue growth is vital for gauging the scalability of acquisition efforts.

• CAC Calculation: The total sales and marketing costs ratio to new customers acquired. Formula: CAC = (Total Sales + Marketing Costs) / New Customers Acquired Example: With monthly acquisition costs of $100,000 for 100 new customers, CAC is $1,000 monthly.

While using these metrics, an important element often missing is the cost of supporting departments, which is incurred indirectly. For example, the HR function provides services for managing the recruiting process and providing HR management services. The finance function might be allocating and calculating the correct cost, budgeting, and doing various performance reports involving Sales and Marketing. This implies that a portion of these services should be measured and added to the Sales and Marketing Costs to determine the more logical total costs related to Sales and Marketing. An appropriate cost-allocation system will ensure fair costs for all the functions and products and will give a realistic picture to the decision-makers.

• Industry Standard: CAC ranges from $500-$1,200 for SMB-focused SaaS models, while enterprise-focused models may exceed $10,000 (ProfitWell, 2022). Businesses must use the relevant benchmark according to their model. The CAC in an enterprise-focused model is high due to factors such as Longer Sales Cycles, Customized and High Touch Sales Approach, Dedicated Sales Team and Account Management, Marketing and Brand Positioning Costs, Higher Onboarding and Implementation Costs, Compliance and Security Requirements and the Focus on Long-Term Customer Lifetime Value. Suppose a business operating in the SMB segment uses CAC as a benchmark for an enterprise-focused model. In that case, it will give a wrong indication of good performance when, actually, it may not.

Reference:

ProfitWell. (2022). SaaS Metrics Benchmarks. Retrieved from https://www.profitwell.com/resources/

3. Churn Rate Churn rate measures customer attrition and is pivotal in understanding retention. High churn indicates limited customer satisfaction or product-market fit, while low churn suggests stability.

• Churn Calculation: The percentage of customers lost in a defined period. Formula: Churn Rate = (Customers Lost During Period / Total Customers at Start of Period) x 100 Example: With an initial base of 1,000 customers and 20 lost, the churn rate is 2%.
• Industry Standard: Monthly churn rates below 1% for enterprise SaaS and 3-5% for SMB-focused SaaS are considered strong (Baremetrics, 2022).

This ratio's limitation is that it does not separate the customers left out of the total at the beginning of the period from those who were added during the period and left. Segregating these statistics should give a better view of the state of affairs. Assuming in the above example, the breakup of the number of customers left is given as: -

Customers left out of the total at the beginning of the period = 15

Customers added during the period and left = 5

Breaking this information into two segments shall give better insight into the Churn Rate.

Reference:

Baremetrics Churn Rate Benchmarks: https://baremetrics.com/benchmarks/churn-rate

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4. Customer Lifetime Value (LTV) LTV estimates the cumulative revenue from a customer relationship, serving as a core indicator of long-term value and retention.

• LTV Calculation: Often calculated as the product of ARPA, gross margin, and the inverse of churn rate. Formula: LTV = (ARPA x Gross Margin) / Churn Rate Example: With an ARPA of $1,000, gross margin at 80%, and a monthly churn rate of 2%, LTV is $40,000.
• Industry Standard: Typical LTVs range between $10,000 and $50,000 for high-growth SaaS companies, though variation is influenced by customer segment and contract terms (For Entrepreneurs, 2022).

The term ARPA stands for Average Revenue Per Account. Care should be exercised while using the formula for LTV calculations and interpreting its result. If a monthly Churn Rate is used, then one must use the monthly value of ARPA, and the resulting LTV will also give a monthly value.

Reference: For Entrepreneurs’ LTV Guide

Skok, D. (2022). SaaS Metrics 2.0 – A Guide to Measuring and Improving What Matters. For Entrepreneurs. Retrieved from https://www.forentrepreneurs.com/saas-metrics-2/

5. CAC to LTV Ratio It should be called LTV to CAC ratio as the formula suggests. However, whatever the ratio is called, it is essential to provide information about how a particular performance metric is calculated. This will enhance understanding and transparency among stakeholders. The CAC-to-LTV ratio is a critical metric in assessing the efficiency of acquisition efforts. A healthy ratio signals that the revenue generated from each customer exceeds acquisition costs, a key consideration in valuations.

• CAC-to-LTV Ratio Calculation: LTV divided by CAC. Formula: CAC-to-LTV = LTV / CAC Example: With LTV at $30,000 and CAC at $10,000, the ratio is 3:1.
• Industry Standard: A ratio of around 3:1 is standard for profitable SaaS businesses, whereas ratios significantly above this can indicate under-investment in acquisition (OpenView, 2022).

Reference:

OpenView CAC-to-LTV Standards: https://openviewpartners.com/

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Strategic Implications for Executives and Investors

For executives and investors, these metrics go beyond operational insights—they drive strategy and valuation. For example, if CAC rises without a corresponding increase in LTV, it may indicate an unsustainable acquisition strategy. A high churn rate, on the other hand, could suggest a need for product improvement or refined customer success efforts.

In an acquisition context, metrics like CAC-to-LTV and churn rate are significant. Investors prioritize SaaS businesses with a CAC-to-LTV ratio around 3:1 and stable or decreasing churn, as these metrics reflect growth potential and revenue reliability. Investment bankers leverage these ratios to shape the investment thesis, linking growth metrics with risk profiles.

Literature

For an in-depth understanding of these concepts, please refer to the following literature.

Peter Fader’s works on customer lifetime value, such as Customer Centricity and Customer Lifetime Value: Prediction Models and Applications, which explore customer retention and revenue in subscription models.

For Entrepreneurs by David Skok, who specifically covers SaaS metrics, including LTV, CAC, and other SaaS-specific calculations.

Baines, P., Fill, C., & Page, K. (2011). Marketing (2nd ed.). Oxford University Press.

Conclusion

Core SaaS metrics—MRR, ARR, CAC, LTV, churn rate, and CAC-to-LTV ratio—are not just benchmarks; they are essential indicators of growth potential, profitability, and strategic direction. For executives and investors, tracking these metrics ensures alignment with business goals, providing a solid foundation for value creation.

For investors, these metrics offer valuable insights into a company’s scalability and efficiency, supporting decisions that align with long-term value. Understanding and leveraging these insights in a competitive SaaS market will ultimately differentiate sustainable success from short-term growth.

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